A Franchisor is Refranchising. Should You Buy?

While “refranchising” may sound like a unique and innovative concept, in reality all it means is that a franchisor has decided to sell its company-owned outlets to independent owners. Franchisors ranging from startups seeking to transition from company ownership to McDonalds and other global brands have undertaken refranchising campaigns with varying degrees of success; and, for prospective franchisees, buying an existing company-owned outlet involves some unique legal and business considerations.

First and foremost, it is important not to lose sight of the fact that there is a reason why the franchisor has chosen to refranchise. If the franchisor doesn’t want to own its stores or restaurants, why should you? While there may be a reasonable explanation for the sell-off (such as unloading unmanageable overhead or capital expenses), as a prospective franchisee, you need to feel confident that you are not buying a sinking ship.

Some other legal considerations for buying an existing company-owned outlet include:

1. Initial Investment

Aside from the purchase price, you are still likely to face a sizable initial investment. Franchisors still typically charge initial franchise fees to “conversion” franchisees, and you may also need to fund remodeling expenses, upgrade costs, and other capital expenditures. You will likely incur some of the other startup costs listed in Item 7 of the Franchise Disclosure Document (FDD) as well; and, even though you are buying an existing business, you will still likely want to establish a sizable capital reserve.

2. Royalties and Advertising Fees

When the franchisor operated the business, it did not have to factor royalties and advertising fees into its profit and loss calculations. But, you will.

3. Liability and Indemnification

As a franchisee, you can expect to have an obligation to indemnify your franchisor for most (if not all) liabilities arising out of your franchise’s operations. However, when buying a company-owned outlet, there should be an exception for liabilities that arose or accrued prior to the date of sale. When negotiating the purchase agreement and your franchise agreement, it will be imperative to ensure that liability is apportioned appropriately.

4. Territory Rights

Oftentimes, franchisors will attempt to sell off company-owned outlets in one or more geographic regions. As with all franchise acquisitions, when buying an existing company-owned location through refranchising, it is important to ensure that you have adequate territorial protections to prevent intra-brand competition from other franchisees and newly-established company-owned locations.

5. Liquidated Damages

If you buy an existing company-owned location and your business fails, agreeing to a liquidated damages clause could mean paying the franchisor for months (if not years) of “lost future royalties.” While many franchisors include liquidated damages clauses as “standard” provisions in their franchise agreements, there are various strategic ways to negotiate the reduction or elimination of lost future royalty obligations.

If you are thinking about buying an existing company-owned outlet and would like more information about the legal risks involved, we encourage you to contact us for a free initial consultation. To speak with national franchise attorney Jeffrey M. Goldstein in confidence, please call 202-293-3947 or inquire online today.